IT Labor Capitalization – IT Project Management

What is IT Labor Capitalization

Capitalizing IT labor refers to the process of recording the cost of IT labor as a capital asset on a company’s balance sheet, rather than expensing it immediately on the P&L.

This means that the labor cost of creating an asset (developing software) or installing hardware is spread out over the useful life of the asset, rather than being recognized as an expense in the period it was incurred.

Why capitalize your IT labor

There are several reasons for capitalizing IT labor including the following:

Capitalizing IT labor increases EBITDA and free Cash Flow.

It reduces operating expense on the income statement and increases the company’s profit margin.

It allows companies to spread the expense over the useful life of the asset, rather than recognizing it all at once.

The depreciation of this new capital asset is a non-cash expense and has no effect on your company’s profit.

Companies can show higher profits in the initial periods, which can be beneficial for reporting purposes and borrowing cost.

It helps to align the costs of development with the revenue generated by the resulting product or service.

Financial metrics, like Asset Turnover, Return on Assets, and Return on Equity are stronger due to having larger capital assets on the balance sheet.

Capitalizing IT labor helps organizations track the costs associated with specific projects more effectively.

Companies that capitalize IT labor are more inclined to invest in technology which can foster innovation.

When companies invest in IT projects, it can signal to employees that the organization values technology and innovation.

What are the key accounting standards?

Generally Accepted Accounting Principles (GAAP) in the US, and International Financial Reporting Standards (IFRS) internationally, provide guidance. &nbsp In the US, ASC 350-10 (Intangibles – Goodwill and Other) and ASC 730 (Research and Development) are particularly relevant. IFRS uses IAS 38 (Intangible Assets). These standards outline specific criteria that must be met for capitalization to be permissible.

What costs can be capitalized?

Generally, direct labor costs associated with developing or significantly enhancing software or other IT assets can be capitalized. This might include salaries, benefits, and related payroll expenses for programmers, developers, testers, project managers, and sometimes business analysts directly involved in the project.

In addition, direct labor cost for preparing, configuring, and installing technology hardware like servers, routers, access points, etc. can be capitalized.

Indirect costs (like overhead, training, or administrative expenses) are usually not capitalized.

How to set-up IT labor capitalization

Time Tracking – The foundation of IT labor capitalization is having a clear record of time spent on these efforts. There are some great over the counter time tracking software options [Clockify, Toggl Track, Harvest, TimeCamp], but you can easily use Excel [Example form].

Estimate hourly rate – You will need to determine an average conversion bill rate for your teammates (contractors are converted at their actual bill rate). Your HR team should be able to provide an average rate based on total compensation (salary + benefits + misc) of your IT teammates.

Records Retention – GAAP, IFRS, and the IRS have rules regarding how to store your records. Some things to keep in mind include Data Integrity (audit trails, access controls, data validation, & system controls), Compliance, Accessability, and Security.

Conversion Process – Once you have your Bill Rates and a system for recording hours, it is simply a matter of multiplying the hours by the bill rates to get your total period Labor Capital. That amount is subtracted (or placed on a seperate line) from the Payroll/Salaries line.

A 2020 study by American Productivity and Quality Center (APQC) found that over 40% of US companies capitalize internally developed software

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